The influence of hedge funds has surged to such a degree that it poses a significant risk to the European energy market, potentially triggering a crisisAfter the recent energy crisis, these hedge funds have flocked to the European gas markets, drawn by the violent price fluctuations that characterize the sectorTheir growing dominance has sprinted past previous levels, leading to fears that they could instigate a market crash.

High-profile funds, such as Millennium Management led by Izzy Englander, Citadel founded by Ken Griffin, and Balyasny Asset Management, have significantly bolstered their workforce in recent yearsCollectively, their commodity trades have netted billions of dollarsBy the end of 2024, the industry is on track to hold a record number of long positions, which amounts to a bet that gas prices will rise.

However, as the year comes to a close, market liquidity is dwindling, and the enormous stakes held by these hedge funds are increasingly setting the stage for greater volatility

Some traders have privately communicated their concerns that such concentration could lead to widespread selling.

Arne Lohmann Rasmussen, the chief analyst at Copenhagen Global Risk Management, expressed, “The high concentration of positions puts pressure on the market and brings it to the brink of a significant collapseWhen everyone's trying to exit at the same moment, it escalates into a real risk.”

While hedge funds, in theory, do not disrupt market operations and can even add liquidity and create trading opportunities, they have been linked to amplified volatility and market shocksA study by the European Central Bank highlighted the role of hedge funds in the government bond market, suggesting their activity can exacerbate fluctuationsFor the electricity and gas markets, such price swings are detrimental as they affect consumers directly and can paralyze the entire sector.

Although these players are not newcomers to the gas market, their involvement has surged dramatically following Europe's energy crisis

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Even though the eurozone has cut its dependence on Russian gas, the region remains vulnerable to international market fluctuations; a single event occurring thousands of miles away can lead to severe price volatility.

This volatility translates into substantial costs for both the industry and consumersMany are now cutting back on consumption to manage their energy billsIn an environment rife with uncertainty surrounding energy costs, Europe's economic recovery is stalling, and more stable pricing—regardless of whether it’s high or low—would enable businesses and households to strategize their expenditures better.

Moutaz Altaghlibi, a senior energy economist at the Dutch bank, commented, “Volatility benefits no one; it complicates the ability of producers and consumers to plan and make informed investment decisions.”

Amid these changes, Millennium Management reported approximately $600 million in revenue from commodity investments in 2023, driven in part by trading in gas and electricity

Citadel’s commodity business similarly generated around $4 billion in profits this yearGriffin, the firm’s founder, remarked in a November interview that the decline in energy demand in Europe “has provided a degree of stability to the market.”

Neither Citadel nor Millennium Management offered comments on their positions, and Balyasny Asset Management also declined to provide statements.

The crux of the issue lies in the speculative bets pursued by hedge funds, which are markedly different from traditional power companies that purchase gas or sell the related output on behalf of their clients.

In a recent email, the EU Agency for the Cooperation of Energy Regulators stated that some of the trading algorithms employed by hedge funds have resulted in a significant increase in liquidity, which benefits all market participantsHowever, this increased trading intensity necessitates better market transparency and stronger monitoring systems.

Concurrently, a representative from the European Securities and Markets Authority indicated that there are no specific guidelines regarding hedge funds' activities within the energy markets.

The future appears poised for more turmoil

Expectations of a cold winter and delays in liquefied natural gas (LNG) projects have dampened confidence that ample supplies will emerge by 2025 to alleviate the price volatility in EuropeConcerns are heightened by rapidly depleting gas inventories and the impending cessation of Russian gas supplies through Ukraine.

In recent weeks, however, the market's pessimism has begun to alleviate thanks to mild weather and increased LNG flowsGiven that speculators have secured substantial positions, any shifts could lead to rapid price changes.

For instance, Maggie Xueting Lin, an energy research strategist at Citigroup, indicated that if gas supplies from Russia continue after the transportation agreement expires at the end of the year (which she considered to be Citigroup's base case assumption), “European gas may be sold off as the market unwinds the risk premium that has been factored in.”

Once new supplies of liquefied natural gas make their way into the market, volatility is likely to eventually subside